3 reasons why the housing market might defy expectations in 2023

Cost of living pressures and higher mortgage rates have dented interest from new homebuyers in the second half of 2022.

The spike in mortgage rates to 6.5% after the mini budget caused widespread alarm, given mortgage rates were just 2% at the start of 2022. Housing market activity has stalled since October as buyers and sellers stand back and wait to see what the outlook is like in January 2023.

Many forecasters have put out bearish predictions for 2023, anticipating house prices falls of 8% to 12% and a significant fallback in sales numbers. Most of these projections are based on expectations of high mortgage rates over 2023 and an economic recession lasting into 2024.

While the outlook is less certain and more challenging for a growing number of households, we are more positive about the prospects for house prices and sales volumes in 2023 for 3 broad reasons.

1. Banks are keen and ready to lend

Many people are looking back at history to draw parallels, in particular the 2007-09 downturn. The 12% drop in house prices over this period was driven by a lack of credit, in that few banks were willing to lend to anyone but the safest customers. This reduced demand for homes and prices fell.

Price falls were also amplified by banks loosening their lending criteria in the run-up to 2007. A third of borrowers didn’t prove their income to their bank in 2007 when applying for a mortgage.

Things are very different today.

UK banks are very well capitalised and their business plans are subjected to regular testing against major downturns in house prices and economic growth. All our high street lenders are mortgage-focused businesses and they will want to make sure credit is available to those that need it in 2023, albeit with higher mortgage rates than at the start of 2022.

Higher interest rates means banks will become more profitable. For existing borrowers, banks are developing a range of options to make sure customers can afford the jump in mortgage rates as they come to the end of fixed term deals.

2. Mortgage rates are dropping

The other big change in recent weeks has been a fall in the cost of money that underpins mortgage rates.

The vast majority of us take fixed rate loans of up to 5 years. After the fallout from the mini budget, the recent fiscal plan from the government has calmed money markets again. This has seen the underlying cost of mortgages fall back to where it was starting to move to earlier in the year.

This means typical mortgage rates for new borrowers taking a 5-year fixed rate will be in the 4.5% to 5% range at the start of 2023.

Higher loan-to-value mortgages will see the higher mortgage rates while those with the biggest deposits, or the most equity in their home, will get the best rates. This factors in further modest increases in the Bank of England base rate in the short term to bring down inflation.

The other important thing to note about mortgage costs is that every homeowner who took out a mortgage over the last 5 years had to prove to their bank they could afford a 6.5% to 7% mortgage rate, even though they may have been paying just 1% or 2%. This so-called affordability stress test was designed to to make sure buyers could afford higher rates.

This is important, and means the housing market has effectively been operating in the background at 6.5% to 7% mortgage rates. It is another key reason we see evidence of underlying resilience in the housing market. If everyone had been buying based on whether they could afford 2% mortgage rates, house price growth would’ve been much higher and we would now be expecting much bigger price falls as a result.

3. Motivations to move home remain

The impacts of the pandemic continue to shape the desire to move home. People who expect to work more flexibly are 6 times more likely to move than those that don’t expect any change in their working style. The proposals from the government to make flexible working more open to employees will support this trend and further loosen the ties between where people live and work.

The pandemic also brought on a jump in the number of people leaving the labour market for health reasons and retirement, which are big triggers for home moves. Those retiring are more likely to have paid off their mortgage or have a small mortgage, so higher mortgage rates are less of a concern – 30% of sales involve no mortgage at all. Many will be looking to move closer to friends and family or to a better area and a smaller home through down-trading.

The jump in energy costs alongside the general increase in living costs are likely to be compounding the drivers to move. This is particularly the case for those concerned about running costs and the suitability of their current home to meet their future needs.

We expect all of these factors to support home moves in 2023, creating demand for homes listed for sale in the new year. We predict there will be 1 million home sales in 2023, which is down 20% on 2022 levels. New buyers will continue to be price sensitive but many sellers have made sizeable gains in their housing equity, giving them some room for movement if they want to move in the year ahead.